In this thread, I began discussing my opinion on the optimum portfolio into retirement. In particular, I introduced my contention that a majority stock portfolio into retirement "wins" historically. To further discuss this topic, and to buttress my argument, I've made an interactive chart that can be accessed here.

Conclusions that I have made from this analysis of stock and bond data over the past 90 years is that around a 80% Stock, 20% Bond portfolio minimizes failure rates at 4% and 5% yearly withdrawal rate (constant, inflation adjusted, proportion of original investment). Furthermore, worst case scenarios (0 and 5th percentile end-of-timespan returns) are also optimized with this majority-stock portfolio.

I was wondering if anyone else, on looking at this data, can come to a different conclusion?

Anticipating some responses, I would like to state that I BELIEVE that:

1) History will repeat itself-ish. The above analysis DOES include the great depression, and still holds true.
2) The retiree does not care about preserving their wealth at any given point in time, but in maximizing their annual constant withdrawal rate. Major unforseen expenses should be covered by having good insurance.

Last edited by Yordle on Fri Dec 23, 2016 1:40 pm, edited 1 time in total.

This retiree (71) is not anticipating a "constant" annual withdrawal rate. For many the withdrawal rate will be greater in early retirement when more physically and mentally active, declining in later retirement when less active, and then perhaps increasing dramatically if nursing care or other living assistance becomes needed.

It's true that higher bond allocations in retirement probably decrease odds of portfolio sustainability, and that higher stock allocations probably increase the odds of portfolio sustainability. More important is that you cannot allocate your way to portfolio sustainability if portfolio size is just too small.

"Everything should be as simple as it is, but not simpler." - Albert Einstein |
Wiki article link:Getting Started

It kind of follows given the assumptions, but I disagree with your 1) and 2) to begin with and think that's misguided if you're taking that actually seriously.

The problem is that the past characteristics probably do not provide the best estimate of the future. Furthermore, we don't have a clear idea of how much wrong that might be and how.

There are a large number of reasons why equity returns might be different from in the past in the US, including constraints from long-term underlying growth, discount rate lower from lower risk (regulatory/legal institutions available now, high liquidity, easy and cheap vehicles for diversification like index funds, potentially less volatile growth cycles, etc.), perhaps lower discount rate for other factors as well such as ERP being well-publicized and known and tax rates, etc.

In 1900-2015, US equity risk premium over bonds was 4.4%. In ex-US it was 2.8%. US equity returns were relatively consistent and high. The lower the ERP in the future, the less it's likely beneficial to have as much stocks.

When making actual withdrawals in practice, unlike the constant-inflation-adjusted-X% examples, you adjust and adapt to new information as it comes in. Because you're not a slave to a hypothetical withdrawal strategy defined 20 years ago, you might make new plans based on the current situation. For any planning, all else equal you can accomplish more with better estimates about the future. Stocks are less predictable than bonds and thus increase the uncertainty about the estimates and thus about what you should and can be doing. There may be fewer disruptions (either positively or negatively) in terms of adjustments needed to "constant" withdrawals in practice if using less stocks.

sambb wrote:I hope stocks do perform well. However during a crash all of these thins assume people will stay the course. If you look back at threads here several people don't stay the course.

Given a large and persistent decline, many people won't have any choice but to sell. The risks of stocks include psychological and economic risks. Much depends on the particulars of the situation, including the investor's ability to cut expenses.

If looking a past performance, it's useful to remember retirements can last 30 or more years and there are only 3-4 independent 30 year periods of reliable stock data. Whether the world is sufficiently similar to 100 years ago to make the data relevant is far from clear.

That's why holding a high percentage of stocks in retirement can be a mistake.

You might want to save yourself some time and effort and read Bill Bengen's seminal work "Conserving Portfolios During Retirement".
While he found stock heavy portfolios delivered the highest SWR rates, he also found that historically the "best" asset allocation depended on both your time horizon and the actual mix of equities.

Also you might be surprised to find how flat the maximum SWR vs % equities curves are between 40% and 80%.

The historical record is pellucidly clear: higher equity (at least 75%) has consistently led to higher SWR in most countries (although the bulk of the studies are for the US). Even the classic study by Bengen that put SWR on the map recognized this.

For retirements beginning after 1931, higher equity allocations - up to and including 100% - hammered lesser allocations in terms of SWR. The sole exception was retirements beginning in the late 60s - the actual SWR 'pinch-point' - where, to a very good approximation, it didn't much matter what your equity allocation was in terms of SWR (although, even here, the 'best' was 75% equity, albeit by a pretty small margin).

100% equity doesn't look so good for retirements beginning with the crash of '29, but even here we see a 'pinch-point' effect with not that much difference in SWR for equity allocations between 0 and 75%.

My takeaway? Based on the historical record, a retirement equity allocation of at least 75% (and possibly a full 100%) is best in terms of SWR. It almost always wins spectacularly, and the few times when it's not the winner it falls short only slightly.

Beyond just the US, Javier Estrada looks at a broader international data set and reaches much the same conclusions. In fact, Estrada even explictly asks, 'Why not 100% stocks?' although in the end he wimps out and recognizes a 60/40 split as undoubtedly more palatable to most retirees.
The Retirement Glidepath: An International Perspectivehttp://papers.ssrn.com/sol3/papers.cfm? ... id=2557256

Of course, all this completely ignores the question of need, willingness, and ability to sustain that kind of equity exposure, and the extent to which history should be our guide in formulating our own retirement plans. But the historical record indicates that a roller coaster ride works better than a smooth, nice & steady, FI-heavy path to living a pinched retirement or even running out of money too soon. Running-out-of-money is a more severe risk than rip-snorting variance risk. In short, history says the roller-coaster ride is, counterintuitively, a safer path than the less bumpy one. But will you sleep at night?

The above are historical facts that just can't be ignored. It is always true that the future is not predicted exactly by the past, but pointing that out without having a better guess what the future will be is not actionable. We already know the past presented any given retiree with a great deal of uncertainty, and nothing has changed that.

I think a key point is that 100% stock allocations are not better or enough better than significantly more conservative ones to avoid the rule to take no more risk than necessary.

The 2008-2009 financial crisis and bear market was a doozy, with peak to trough losses of over 50% for stocks. Fortunately, stocks recovered relatively quickly as compared to the 1929 crash. My vague recollection of market history says that it took the markets until after the end of WWII for markets to completely recover from the 1929 crash and bear market. Losses, peak to trough were about 80%. In 2008-2009, it took less than five years for recovery.

Not sure I want to take an 80% stock/20% bond portfolio through the Great Depression.

Nevertheless, I feel a lot better reading this thread. I have about 2/3 stocks and 1/3 fixed income at 57 years of age in my retirement portfolio. I don't feel as much of a riverboat gambler.

Did some checking recently on what are the risks to markets in reality. The usual, but probably often not recalled.
ERP(eq. risk premium)> this confounded me for a long time. I was always very apprehensive of stock funds even though I was always invested in them in the majority. I didn't understand how stocks were priced, and, consequently, really thought it was 100% a casino game. Now I know, vaguely, that it's a relative priced risk in relation to all other risks/returns available to the markets.

So, I'm edged to think that the ERP is there, and performs correctly on average. So, what's to worry?
Well, I come to the more macro concerns. It's the economy! There are ,in addition, other more macro risks such as: country risks (economic and political), business/economic cycles, Shiller's PE10, a maturing economy as in age demographics or, I don't know, depletion of natural resources, or maybe another: productivity/employment maximization? ; and I read some on supercycles.
Long term (50 year?) cycles, they were conceived on agriculture and mining products, within large area economies that were observed to have growth and recessionary cycles of 50 years by http://www.investopedia.com/terms/k/kon ... f-wave.asp, also info of this in the Elliot Wave Theory, each applying to stock markets also (though not to espouse TA, just interesting.)
And there were the periods of 1870?, 1929, 1970's?, 2008, at least in the U.S.
So, these economic type of risks concern me more when looking at longer than ten years into the future.
One consolation is that everyone will, to a large degree, be in the same boat.
So, as some have been concerned in other threads, there could be something like these (1870, 1929, 1970's, 2008)(and what has occurred in world countries) that occur over and above the volatility occurrances that happen in between. To me, these macro risks aren't compensated for.
So, actionable by reducing equities (largely not worth it, to me), or just keeping fingers crossed.

Yordle wrote:...Conclusions that I have made from this analysis of stock and bond data over the past 90 years is that around a 80% Stock, 20% Bond portfolio minimizes failure rates at 4% and 5% yearly withdrawal rate (constant, inflation adjusted, proportion of original investment)...

No, you have misspoken, and while it may seem trivial I don't think it is. I think it is important to maintain constant vigilance on the verb tenses we use. All you could possibly have concluded is that this would have minimized failure rate.

A second problem is that nobody knows how to make a proper allowance for fat tails, black swans, and "record-breaking" events. When I say nobody knows, that's what I mean. However, I think those of us who are reluctant to have a high stock allocation in retirement are reacting to an intuitive feeling that high stock allocations are more "fragile" (just as leverage, which often looks good in simulations, makes things "fragile.")

The "argument from 1926-present" is unfortunately not a very robust one. As noted that time period includes only three non-overlapping thirty-year periods. It also includes only one single up-and-down excursion of bond interest rates. We are completely accustomed to records constantly being broken in sports, it is not surprising that the same thing happens in financial data. In the fifth edition of Stocks for the Long Run, in 2014, Jeremy Siegel said, very forthrightly:

In the first four editions of Stocks for the Long Run, I noted that the last 30-year period when the return on long-term bonds beat stocks ended in 1861, at the onset of the Civil War. That is no longer true.

That's fine if we're just exploring statistics, not so fine if we personally staked much on the idea that it would always be true. (Amazingly, people still continue to say, though not as a direct quotation of Siegel, that "stocks always beat bonds over periods of thirty years.")

All the data we have is all the data we have. That doesn't mean it's enough data to make reliable predictions from, however.

A continuing strain in the utterances of risk-taking professionals, when their leveraged structures collapse, is "that was a ten-sigma event." Not really our fault, we were the victims of such bad luck that nobody could possibly have foreseen and which shouldn't count against us. Well, a ten-sigma event is not so bad if it happens to somebody else's money you are managing, but it is not so good if it happens to your own money. It is pretty clear that "ten-sigma events" happen a lot more often than once in 60,000,000,000,000,000,000,000 years, so I'm pretty sure that the constant occurrence of "ten-sigma events" is not the result of bad luck, but of inaccurate models that don't allow for fat tails.

A third problem is that you are simply neglecting the issue of personal risk tolerance in retirement, how you will feel and how you will behave if you are 85 years old and see half of your wealth wiped out in a few months, even if you know that you are still ahead of where you might have been with a conservative allocation, and even if you think that the stock market will come back within ten years.

Last edited by nisiprius on Sun Dec 18, 2016 3:45 pm, edited 3 times in total.

I began discussing my opinion on the optimum portfolio into retirement. In particular, I introduced my contention that a majority stock portfolio into retirement "wins" historically.

You can discuss your opinion on your optimum portfolio, but you simply cannot suggest an optimum portfolio for every investor because each has different need, financial ability, and sensitivity to risk (willingness). At any rate, it's fine to open a discussion to get other perspectives.

I've heard stocks are risky, but I cannot tell you precisely what that might mean for the next 25 years. Past data is not reliable for predicting future outcomes.

Having said that, I can tell you that the Dow lost almost 90% in the aftermath of the crash of '29, and the NASDAQ lost 78% in the tech crash.

Our family owned "Larimore's Diner" in Foxboro, Mass. in 1929 (I was 5 years old at that time). When the depression hit, we lost the Diner and moved into my grandfather's home in Miami. Grandfather, who was a millionaire investor and chief executive of an investment trust company, lost everything--including the Miami home we lived in.

Figures cannot convey the horrifying and debilitating effects of a bear market. You watch in agony as month after month your life savings evaporate before your eyes. Gloom and doom talk is everywhere. Nearly everyone else is selling. You have no idea when, or if, your portfolio will stop losing money.

Your friends and relatives urge you to sell. Nearly all financial experts recommend "sell". You are ridiculed for trying to hold on. You begin to have self-doubt. Despair sets in. Buying stocks is unthinkable. Suicides increase. That's a REAL bear market.

Considering the numbers from '29 and 2000, ask yourself, do I have the financial ability to sustain that kind of loss? On the other hand, something like that may not happen again. Also consider that max loss in any crash for the past 45 years has been 50%, but can you take that to the bank? No. Sure, really bad outcomes are rare, but you might read Wm Bernsteins article on deep risk. Stocks really are risky. The change of a very low-probability ugly outcome always lurks behind the door.

I've seen the papers on withdrawal rates, and yes, it appears higher equity allocations are safer as one ages, but it still depends on each individuals situation.

If your withdrawal rate in retirement is 2% or less, then you have quite a bit of ability to take on high risk. If you withdrawal rate is >4%, then you probably don't. And, of course, each investor has a different limit on emotional tolerance for losses.

Finally, If you want to be 100% equity, that's Ok, just be sure you have all the needed facts, but be careful giving that advice to other investors whose situations you don't know.

Paul

When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

Yordle wrote:
2) The retiree does not care about preserving their wealth at any given point in time, but in maximizing their annual constant withdrawal rate. Major unforseen expenses should be covered by having good insurance.

I take issue with that assumption, on more than one point.

First objection - Probably my biggest fear in retirement is the need for LTC. There have been several threads on LTC insurance on this forum and the consensus, last I looked, was "don't bother - you won't get what you expect or need from it". There are other black swans but that one is such a possibility that is more of a brown swan than a black one.

Second point - I am not at all trying to maximize my withdrawals. Our withdrawals are pretty much determined by budget, not the other way around. But this goes back to point #1 - I feel that my best option for dealing with black swans and in particular LTC is to self-insure. That to me means lots of reserves and risk management. Reserves come from under-spending. Risk management means several things, but one of those is diversification.

Bottom line is while during accumulation it was all about maximizing assets, my mind set now is around maximizing risk-adjusted returns.

nisiprius wrote:<snip>
The "argument from 1926-present" is unfortunately not a very robust one. As noted that time period includes only three non-overlapping thirty-year periods. It also includes only one single up-and-down excursion of bond interest rates. We are completely accustomed to records constantly being broken in sports, it is not surprising that the same thing happens in financial data. In the fifth edition of Stocks for the Long Run, in 2014, Jeremy Siegel said, very forthrightly:

In the first four editions of Stocks for the Long Run, I noted that the last 30-year period when the return on long-term bonds beat stocks ended in 1861, at the onset of the Civil War. That is no longer true.

That's fine if we're just exploring statistics, not so fine if we personally staked much on the idea that it would always be true. (Amazingly, people still continue to say, though not as a direct quotation of Siegel, that "stocks always beat bonds over periods of thirty years.")

All the data we have is all the data we have. That doesn't mean it's enough data to make reliable predictions from, however.

<snip>

When people say that "stocks always beat bonds over periods of thirty years", why do you suspect they are talking about long-term treasuries? It's clear that the phrase includes the wrong verb tense. Even so, I doubt you would invest your fixed-income portfolio in LT treasuries, so it isn't the right benchmark at all. It may indeed be the case that there has not been a thirty-year period where stocks have failed to beat a total bond market type fund. An important corollary to your "use the right verb tense" lesson is that you need to use the corresponding benchmark looking backward as you intend to use going forward. Are you so sure that a well-diversified (credit and duration) bond portfolio sometimes beat stocks over 30 years? I'm not.

"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

nisiprius wrote:<snip>
The "argument from 1926-present" is unfortunately not a very robust one. As noted that time period includes only three non-overlapping thirty-year periods. It also includes only one single up-and-down excursion of bond interest rates. We are completely accustomed to records constantly being broken in sports, it is not surprising that the same thing happens in financial data. In the fifth edition of Stocks for the Long Run, in 2014, Jeremy Siegel said, very forthrightly:

In the first four editions of Stocks for the Long Run, I noted that the last 30-year period when the return on long-term bonds beat stocks ended in 1861, at the onset of the Civil War. That is no longer true.

That's fine if we're just exploring statistics, not so fine if we personally staked much on the idea that it would always be true. (Amazingly, people still continue to say, though not as a direct quotation of Siegel, that "stocks always beat bonds over periods of thirty years.")

All the data we have is all the data we have. That doesn't mean it's enough data to make reliable predictions from, however.

<snip>

When people say that "stocks always beat bonds over periods of thirty years", why do you suspect they are talking about long-term treasuries? It's clear that the phrase includes the wrong verb tense. Even so, I doubt you would invest your fixed-income portfolio in LT treasuries, so it isn't the right benchmark at all. It may indeed be the case that there has not been a thirty-year period where stocks have failed to beat a total bond market type fund. An important corollary to your "use the right verb tense" lesson is that you need to use the corresponding benchmark looking backward as you intend to use going forward. Are you so sure that a well-diversified (credit and duration) bond portfolio sometimes beat stocks over 30 years? I'm not.

The blue quote is important I think to highlight the lack of sufficient data for any sort of strong statements regarding historical results, especially on the bond side as this is not brought up too often.

The red quote raises an issue that always bothers me, so I am just agreeing with triceratop. I agree that the only reasonable comparison is total stock vs total bonds. Otherwise one is just cherry picking assets. If someone wants to cherry pick a particular bond, let me cherry pick the stocks and let's see who comes out ahead.

Last edited by Rodc on Sun Dec 18, 2016 8:38 pm, edited 3 times in total.

We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

The " glide path " of life events is my guide as I age. My original AA was never over than 60/40 and a few years ago I bEgan reducing it, a bit past the normal glide path reccomendation because our pensions more than cover our life style In retirement, to 45/55. Now we are considering another , lower, AA adjustment as we're in our mid 70's and a long bear may not be recoverable for us. Another post here says retirees initially need more buck$ for travel and vacations, Etc. then less. That's us to a Tee! Then more money , possibly , as the infirmatives set-in. (We're in a very nice CCRC with all of late life's amenities, and that is a great relief!) Just saying that taking on more risk at our age is just to scary! (Not necessary either..)

SeMoe..

"By gnawing through a dike, even a Rat can destroy a nation ." {Edmund Burke}

rapporteur wrote:Beyond just the US, Javier Estrada looks at a broader international data set and reaches much the same conclusions. In fact, Estrada even explictly asks, 'Why not 100% stocks?' although in the end he wimps out and recognizes a 60/40 split as undoubtedly more palatable to most retirees.

David Blanchett in "Dynamic Allocation Strategies for Distribution Portfolios" had the same conclusions and the same wimp out

Out of 1,071 variations of asset allocations over retirement (including various kinds of glidepaths), the "100% stocks" allocation performed best 55% of the time; nothing else was even close. The second best asset allocation was only optimal 8% of the time. Yet at the end, on the basis of no evidence that he presented whatsoever, he recommends a 60/40 portfolio.

nisiprius wrote:The "argument from 1926-present" is unfortunately not a very robust one. As noted that time period includes only three non-overlapping thirty-year periods.

Luckily we aren't restricted to US data; we also have global data from 1900 to the present which gives us 3 non-overlapping periods per country and 19 countries = 57 non-overlapping periods. The results continue to hold with the expanded dataset and 57 non-overlapping periods.

Oh look, another maximizing returns thread! It's great that, statistically speaking, a given allocation bests all others. It's too bad it's not possible to get the same statistics using a control group of real investors. Like, say, the ones Taylor relates in his stories.

If you are comfortable setting your investment course based upon faith in a statistically-safe model then good for you. Ill aim the must-have money toward assets that have demonstrated less risk, and leave the rest to grow.

Last edited by swguy on Sun Dec 18, 2016 10:12 pm, edited 1 time in total.

nisiprius wrote:The "argument from 1926-present" is unfortunately not a very robust one. As noted that time period includes only three non-overlapping thirty-year periods.

Luckily we aren't restricted to US data; we also have global data from 1900 to the present which gives us 3 non-overlapping periods per country and 19 countries = 57 non-overlapping periods. The results continue to hold with the expanded dataset and 57 non-overlapping periods.

I guess that you are referring to the DMS dataset. Do you actually have access to it (it isn't cheap)? Did you run such analysis yourself? It would be great to see something like that...

In this thread, I began discussing my opinion on the optimum portfolio into retirement. In particular, I introduced my contention that a majority stock portfolio into retirement "wins" historically. To further discuss this topic, and to buttress my argument, I've made an interactive chart that can be accessed here.

Conclusions that I have made from this analysis of stock and bond data over the past 90 years is that around a 80% Stock, 20% Bond portfolio minimizes failure rates at 4% and 5% yearly withdrawal rate (constant, inflation adjusted, proportion of original investment). Furthermore, worst case scenarios (0 and 5th percentile end-of-timespan returns) are also optimized with this majority-stock portfolio.

I was wondering if anyone else, on looking at this data, can come to a different conclusion?

Anticipating some responses, I would like to state that I BELIEVE that:
1) History will repeat itself-ish. The above analysis DOES include the great depression, and still holds true.
2) The retiree does not care about preserving their wealth at any given point in time, but in maximizing their annual constant withdrawal rate. Major unforseen expenses should be covered by having good insurance.

No. Came to the same conclusions. In 2008 (58/61yo) when I realized in the depths of the GR, that the best way out was an all-equity portfolio in a new extended time frame. No guts, No glory. Your results are well known.
Short-term and Medium-term periods, the results are different. This is also well known.
The real problem is Behavior. Your human capital, accumulated wealth, and life expectancy will shape your Behavior.
YMMV

ruralavalon wrote:My two cents.
This retiree (71) is not anticipating a "constant" annual withdrawal rate. For many the withdrawal rate will be greater in early retirement when more physically and mentally active, declining in later retirement when less active, and then perhaps increasing dramatically if nursing care or other living assistance becomes needed.

If the retiree is to withdraw a lot more at the end-of-life, a more stock oriented portfolio makes even more sense, atleast early on. Stocks do excellent with low (<4%) withdrawal rates.

lack-ey wrote:The problem is that the past characteristics probably do not provide the best estimate of the future. Furthermore, we don't have a clear idea of how much wrong that might be and how

Quark wrote:If looking a past performance, it's useful to remember retirements can last 30 or more years and there are only 3-4 independent 30 year periods of reliable stock data. Whether the world is sufficiently similar to 100 years ago to make the data relevant is far from clear.

The past is all we have. I'd argue making predictions on the past makes a lot more sense than "trying" to predict the future based on... based on what? It's not the best, but it's all we have! Other comments argue that it makes more sense to go more with bonds because they are "less" risky. First, this forgets that stock volatility approaches bond volatility over long timespans. Second, imagine these scenarios:

1. Retiree with more money than he needs. This retiree will only require <4% withdrawal rate. 100% Stocks should be the best for him.
2. Retiree with maybe just enough money. What if the retiree lives till 100? A mostly bond fund may be exhausted based on historical analysis with a 4% withdrawal rate after >30 years, whereas the stock fund has a higher probability of lasting this long. (jalbert, I'm pretty sure your comment that less equities increases your risk of outliving your assets is wrong... and indeed it's the opposite that is true)

sambb wrote:I hope stocks do perform well. However during a crash all of these thins assume people will stay the course. If you look back at threads here several people don't stay the course.

Yup. You need to be able to stomach a crash. But you'll be smiling after it's over, more often than not. I think some people are capable of this exercise in delayed gratification. You just have to be sure you are one of those people.

rapporteur wrote:
My takeaway? Based on the historical record, a retirement equity allocation of at least 75% (and possibly a full 100%) is best in terms of SWR. It almost always wins spectacularly, and the few times when it's not the winner it falls short only slightly.

Beyond just the US, Javier Estrada looks at a broader international data set and reaches much the same conclusions. In fact, Estrada even explictly asks, 'Why not 100% stocks?' although in the end he wimps out and recognizes a 60/40 split as undoubtedly more palatable to most retirees.
The Retirement Glidepath: An International Perspectivehttp://papers.ssrn.com/sol3/papers.cfm? ... id=2557256

Thank you so much for the additional supporting resources. Why indeed did the author wimp out? Why are most "expert" guidelines all recommending a bond heavy portfolio? I agree, some people can't stomach a crash... but I believe people should be presented a more nuanced discussion of the topic. Dogma is a hard thing to change.

nisiprius wrote:The "argument from 1926-present" is unfortunately not a very robust one. As noted that time period includes only three non-overlapping thirty-year periods.

Luckily we aren't restricted to US data; we also have global data from 1900 to the present which gives us 3 non-overlapping periods per country and 19 countries = 57 non-overlapping periods. The results continue to hold with the expanded dataset and 57 non-overlapping periods.

I guess that you are referring to the DMS dataset. Do you actually have access to it (it isn't cheap)? Did you run such analysis yourself? It would be great to see something like that...

No, I'm too cheap But Javier Estrada has written a series of papers using it. He told me he's currently working on a paper looking at variable withdrawal strategies using the DMS database but it'll be a while before drafts are available.

On average across the 19 countries in the sample, then, it is the case that, relative to the five lifecycle strategies, all 10 alternative (five contrarian, three equity-driven, two balanced) strategies considered here provide investors with 1) higher mean and median terminal wealth; 2) higher upside potential; 3) more limited downside potential; and 4) higher uncertainty about their terminal wealth, but are largely limited to how much better, not how much worse, investors are expected to fare with them.

Last edited by AlohaJoe on Mon Dec 19, 2016 12:19 am, edited 1 time in total.

Yordle wrote:Why are most "expert" guidelines all recommending a bond heavy portfolio? I agree, some people can't stomach a crash... but I believe people should be presented a more nuanced discussion of the topic. Dogma is a hard thing to change.

Interestingly enough, 20 or 30 years ago, experts were mostly discussing a 60/40 portfolios and were keenly aware of the need for stocks as an engine of growth in a retirement portfolio. This was at a time where many people vividly remember the oil crisis, which was really two-fold, a very severe drop for stocks, followed by a period of wild inflation which created all sorts of painful issues with bonds. I think people were also keenly aware of the major bonds crisis of the 40s, where bonds didn't recover for the following 45 years (in real terms), the worst crisis of any investment vehicle ever - as well as the bonds default from other governments after the war. And their parents or grandparents were telling them stories about the great depression, of course, and its double-whammy 1929/1937. That was all fodder for balanced views.

Nowadays, we see a lot of views distorted by the great bond bull market of the past few decades. And then suddenly, all people can remember are the recent stock crisis (which were admittedly very painful), while bonds magically became 'safe'. Which is just short-term memory and recency bias, nothing else. And now some 'experts' make truly irresponsible recommendations of going 30/70 when you retire. At a time of low interest rates. Sigh.

The final nail on the coffin is this weird definition of 'risk' as short-term volatility, and those silly ratios dividing returns by standard-deviation and so on. William Sharpe was a brilliant mathematician, but man, he did a lot of damage here by making many people believe that risks in real-life can be summarized with one little equation. No, sorry, risks span your lifetime, and can't be reduced to a sudden drop.

Fact is both bonds and stocks come with very severe risks. Fact is we all have very different personal circumstances, goals, and behavior. You would have to skin me alive to make me give up on stocks at the bottom of a crisis. I would be deeply anguished by the crisis for sure, no question, but the last thing on my mind would be to further damage myself by changing my AA at such a time. Other people might not react in the same way, that is clear. Or would be significantly less anguished by less steep drops in their portfolio (while ignoring the growth pattern of the past years). We're all different.

OP, I believe you're doing the right thing by analyzing the past in depth. Yes, the future might rhyme with the past or be quite different, nobody knows, but the more you understand what happened, and the mistakes to avoid, the better shape you will be to handle an uncertain future. Then your AA is your personal choice, 80/20 may very well be the right choice for you, while a more balanced 60/40 would be a better choice for somebody else. You can't defuse the 80/20 approach by numbers analysis, as you've rightfully observed. But this doesn't mean this is compatible with your goals and behavior. Only you can figure that out...

AlohaJoe wrote:But Javier Estrada has written a series of papers using it. He told me he's currently working on a paper looking at variable withdrawal strategies using the DMS database but it'll be a while before drafts are available.

Ah, this is *EXCELLENT*. I did read his existing literature, but alas, constant-withdrawal analysis doesn't prove much... Well, if he's looking for early reviewers, I would happily put my name in the hat!

siamond wrote:The final nail on the coffin is this weird definition of 'risk' as short-term volatility, and those silly ratios dividing returns by standard-deviation and so on. William Sharpe was a brilliant mathematician, but man, he did a lot of damage here by making many people believe that risks in real-life can be summarized with one little equation. No, sorry, risks span your lifetime, and can't be reduced to a sudden drop.

Why indeed did the author wimp out? Why are most "expert" guidelines all recommending a bond heavy portfolio? I agree, some people can't stomach a crash... but I believe people should be presented a more nuanced discussion of the topic. Dogma is a hard thing to change

Yes indeedy. As Keynes wryly observed, “Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally.” And so Estrada (and Bengen) may have felt obliged to pander to the received wisdom that stocks are too ‘risky’ to form the bulk of a retirement portfolio. (Well, if not to outright pander to received wisdom, at least to nod in its direction by softening their conclusions.)

Most humans are very poor at assessing and managing long term risks. Our innate risk management instincts are very short term: Movement in the grass? – Run, it may be a tiger! And so, as Bernstein points out in ‘Deep Risk’, we mistake variance, a reasonable measure of short-term ‘shallow risk’ as being a good way to manage a long-term retirement. Accordingly, an equity-heavy retirement portfolio seems very scary! But all the evidence, over most of the globe and over a century or more shows that it has been, by far, the safest and most prudent course of action. Yes, over the course of a 30-year retirement there’s lots of variance in an equity-heavy portfolio but, net, it’s to the upside! That’s pretty sweet!

It’s a bond-heavy portfolio that will have you living a pinched retirement even in moderate times, and sleeping in doorways if ‘deep risk’ (such as rampant inflation) comes to pass. (Or conversely, postponing the start of a pleasant retirement in lieu of building up an ever greater and greater 'stash' before daring to retire on the meagre proceeds of a fixed-income retirement portfolio. Want a ‘safe’ 80% bond portfolio these days? Well, better be prepared to work long and hard to hit your required ‘multiple’ before retiring.)

So, as we see with the objections that have been raised in this thread, it is very hard not to let those butterflies in the stomach conjure up objections (ostensibly very rational objections!) to going where the evidence leads.

Because, of course, as Nisiprius rightly points out, despite the historical evidence, there is no guarantee that some equity-collapse black swan won’t get us. But what I think he gives far too little weight is that a bond-heavy portfolio very probably will provide even poorer protection against other black swans, such as high inflation, or the very real risk of simply running out of money, or will simply have us settling for a postponed and pinched retirement in overwrought fear of black swans.

Because, yes, life is risky – no one gets out alive! Even despite me building up a gigantic portfolio, nuclear war might happen next year. ...or an asteroid might destroy all life… ...or some other black swan. The best-laid schemes of mice and men… Such is the human condition and we must learn (i.e., teach ourselves) to live with it.

So, since the future is uncertain and since we can seldom eliminate risk, we must settle instead for managing it – managing it under uncertainty as best we can. However, despite the future being uncertain, I suggest the prudent and wise way to manage is to go where the evidence leads. And that evidence militates in favour of high-equity retirement portfolios (subject always to need, ability, and willingness to take risk, but also making sure that our assessment of that need, ability, and willingness is not crippled by psychological hobgoblins of our own making).

Yordle wrote:...The past is all we have. I'd argue making predictions on the past makes a lot more sense than "trying" to predict the future based on... based on what? It's not the best, but it's all we have!...

No, the past is not all we have. For example, Vanguard looked at various methods of forecasting returns and concluded p/e (or CAPE) was better than looking at historic data. It wasn't great, but it was better. https://personal.vanguard.com/pdf/s338.pdf

There's also the problem that we don't have enough reliable useful data. We're trying to predict retirement and a typical period to analyze is 30 years. We don't even have four reliable independent 30 year periods to look at, and even four data points is not enough. Older data is not reliable and is not really comparable to today. If you flipped a coin three times and got heads, would you conclude getting tails was impossible?

Yordle wrote:...The past is all we have. I'd argue making predictions on the past makes a lot more sense than "trying" to predict the future based on... based on what? It's not the best, but it's all we have!...

No, the past is not all we have. For example, Vanguard looked at various methods of forecasting returns and concluded p/e (or CAPE) was better than looking at historic data. It wasn't great, but it was better. https://personal.vanguard.com/pdf/s338.pdf

There's also the problem that we don't have enough reliable useful data. We're trying to predict retirement and a typical period to analyze is 30 years. We don't even have four reliable independent 30 year periods to look at, and even four data points is not enough. Older data is not reliable and is not really comparable to today. If you flipped a coin three times and got heads, would you conclude getting tails was impossible?

If I'm not mistaken... does not this Vanguard paper measure the utility of various methods at predicting historical returns? This is still using history to predict the future. Instead of historical returns though... it's historical p/e ratios or whatever.

Yordle wrote:If I'm not mistaken... does not this Vanguard paper measure the utility of various methods at predicting historical returns? This is still using history to predict the future. Instead of historical returns though... it's historical p/e ratios or whatever.

Yes, that's true. In one sense, using such probabilistic projection is probably a tad closer to the truth (what unduly went up has to go down at some point, and US stocks valuations appear quite high nowadays and bond yields quite low, so the coming decade might be quite dire, more than the average decade in history). On the other hand, this is about a mid-term prediction (e.g. a decade or two), this is NOT about the rest of your lifetime. On the third hand (!!), it is surprising to see how an unfortunate starting point impacted (downward) subsequent 30-yrs time periods. Bottomline: this is a VERY blunt instrument, but it reinforces caution when making assumptions about future returns.

Amusingly enough, I don't believe this should impact an AA decision. Stock-minded people may actually be reinforced by the need to keep an engine of growth in their portfolio, even a sputtering one. While bond-minded people may also be reinforced in their beliefs, fearing a looming stock crisis. Overarching consideration is simple, stay the course, whatever it is.

Yordle wrote:...The past is all we have. I'd argue making predictions on the past makes a lot more sense than "trying" to predict the future based on... based on what? It's not the best, but it's all we have!...

No, the past is not all we have. For example, Vanguard looked at various methods of forecasting returns and concluded p/e (or CAPE) was better than looking at historic data. It wasn't great, but it was better. https://personal.vanguard.com/pdf/s338.pdf

There's also the problem that we don't have enough reliable useful data. We're trying to predict retirement and a typical period to analyze is 30 years. We don't even have four reliable independent 30 year periods to look at, and even four data points is not enough. Older data is not reliable and is not really comparable to today. If you flipped a coin three times and got heads, would you conclude getting tails was impossible?

If I'm not mistaken... does not this Vanguard paper measure the utility of various methods at predicting historical returns? This is still using history to predict the future. Instead of historical returns though... it's historical p/e ratios or whatever.

Question: is history a good forecasting method:

1) Assume no. Stop. No need to proceed.

2) Assume yes. If it's a good method, then it should have performed well in the past. Has it? According to Vanguard, not as well as p/e and neither are all that good.

Therefore, whether or not you initially believe history is a good method, you're eventual conclusion is that it is not.

2) Assume yes. If it's a good method, then it should have performed well in the past. Has it? According to Vanguard, not as well as p/e and neither are all that good.

Therefore, whether or not you initially believe history is a good method, you're eventual conclusion is that it is not.

To clarify some language again, basically every predictive model is based on history, incorporating past return data.

In many kinds of systems or processes, taking the sample mean or some kind of historical average is in some statistical senses the optimal estimator of the true underlying average behavior. That's what many people here mean by "using history." This is particularly the case in a standard kind of scenario where you're looking at independent events and this ends up averaging out independent noise terms on each observation. It's not particularly good in the kind of situation where the underlying behavior and conditions are changing over time.

For many economic/business reasons, this doesn't seem like it should hold for examining historical returns data. Examining the historical data shows some evidence against that approach and hints about a modest degree of return predictability (above assuming the average) in the direction that would square with economic theory. Of course it's not like there's an abundance of data available to make a case for any given model, and maybe that's not how the relationship will actually be in the future.

Anyway, none of that has all that much impact on the broader issue of retirement asset allocation. Stocks are significantly more uncertain than bonds, though likely overall better. My actual takeaway is not that bonds are any good either, but that you should consider real estate and/or annuities (particularly deferred, to help cut longevity tail risk) to supplement both stocks and bonds.

nisiprius wrote:The "argument from 1926-present" is unfortunately not a very robust one. As noted that time period includes only three non-overlapping thirty-year periods.

Luckily we aren't restricted to US data; we also have global data from 1900 to the present which gives us 3 non-overlapping periods per country and 19 countries = 57 non-overlapping periods. The results continue to hold with the expanded dataset and 57 non-overlapping periods.

A challenge I do not know how to resolve is that each country is operating in the same global economy. They all, or at least most, had a significant depression in the 1930s, they all operated in a world at war in the 19-teens and the 19-forties. And the interdependence has only gown over time. So returns in the 1930s for example all share a strong underlying connection, for example. Different country returns most definitely are not independent.

We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

2) Assume yes. If it's a good method, then it should have performed well in the past. Has it? According to Vanguard, not as well as p/e and neither are all that good.

Therefore, whether or not you initially believe history is a good method, you're eventual conclusion is that it is not.

To clarify some language again, basically every predictive model is based on history, incorporating past return data.

In many kinds of systems or processes, taking the sample mean or some kind of historical average is in some statistical senses the optimal estimator of the true underlying average behavior. That's what many people here mean by "using history." This is particularly the case in a standard kind of scenario where you're looking at independent events and this ends up averaging out independent noise terms on each observation. It's not particularly good in the kind of situation where the underlying behavior and conditions are changing over time.

For many economic/business reasons, this doesn't seem like it should hold for examining historical returns data. Examining the historical data shows some evidence against that approach and hints about a modest degree of return predictability (above assuming the average) in the direction that would square with economic theory. Of course it's not like there's an abundance of data available to make a case for any given model, and maybe that's not how the relationship will actually be in the future.

Anyway, none of that has all that much impact on the broader issue of retirement asset allocation. Stocks are significantly more uncertain than bonds, though likely overall better. My actual takeaway is not that bonds are any good either, but that you should consider real estate and/or annuities (particularly deferred, to help cut longevity tail risk) to supplement both stocks and bonds.

Quite a bit of entrenchment here for age-in-bonds or like. Only leadership will get some out into the open. Only when faced with certain doom in people's current situation will some take the action of change.
YMMV

2) Assume yes. If it's a good method, then it should have performed well in the past. Has it? According to Vanguard, not as well as p/e and neither are all that good.

Therefore, whether or not you initially believe history is a good method, you're eventual conclusion is that it is not.

To clarify some language again, basically every predictive model is based on history, incorporating past return data.

In many kinds of systems or processes, taking the sample mean or some kind of historical average is in some statistical senses the optimal estimator of the true underlying average behavior. That's what many people here mean by "using history." This is particularly the case in a standard kind of scenario where you're looking at independent events and this ends up averaging out independent noise terms on each observation. It's not particularly good in the kind of situation where the underlying behavior and conditions are changing over time.

For many economic/business reasons, this doesn't seem like it should hold for examining historical returns data. Examining the historical data shows some evidence against that approach and hints about a modest degree of return predictability (above assuming the average) in the direction that would square with economic theory. Of course it's not like there's an abundance of data available to make a case for any given model, and maybe that's not how the relationship will actually be in the future.

Anyway, none of that has all that much impact on the broader issue of retirement asset allocation. Stocks are significantly more uncertain than bonds, though likely overall better. My actual takeaway is not that bonds are any good either, but that you should consider real estate and/or annuities (particularly deferred, to help cut longevity tail risk) to supplement both stocks and bonds.

My general concept regarding means, std devs and the like is that you take a random sample from a population. You might be able to derive a fair degree of confidence that the sample reflects the population.

This model doesn't work well for historical returns because, among other issues, the underlying population could be changing over time, you're not taking a random sample and you don't have enough independent data points.

My earlier point about history was that, based on history, Vanguard's study indicates history is not a reliable guide. If Vanguard's study is flawed because history is not a reliable guide, then history is not a reliable guide. In either event, history doesn't seem a reliable guide. p/e works better, but not all that well.

Annuities can be a good idea, depending on circumstances. Real estate is a longer discussion.

History may not be a reliable guide, but it's the ONLY guide we have (unless, perhaps, someone has access to a burning bush or unclouded crystal ball). All there is - regarding ANY subject, from dog training to quantum mechanics and everything else as well - is past data. History!

It's how one uses that past data - history - to formulate predictions and make plans for the future. It can range from expecting simple repetition, to naive extrapolation, through parametric and non-parametric statistical treatment, to developing models, to going 'full quant' and torturing the numbers until they scream. And one can cast one's net as narrowly or broadly as one wishes, dragging in, if one chooses, anything from exogenous variables such as GDP, to the lengths of women's hemlines, to Chinese rice production during the Ming dynasty, or to the signs of the zodiac. Some methods of using history will be better than others - in fact, some may be worse than useless. But, in the end, there is only history, what we can learn from it (either first hand or leaning on the work of others), how we apply it, and how confident we are in what we infer from it.

Regards,

PS In the context of this thread, however, the main point is that vague misgivings, and even very boisterous butterflies in one's stomach, do not constitute sufficient reason for jettisoning the historical record. In planning our retirements, putting our fingers in our ears and humming loudly to avoid dealing with disquieting historical fact is likely to prove, shall we say, markedly suboptimal

Agreed. Just because an approach is better when historically backtested, that does not mean is can be successfully applied by a broad segment of the population in the future. There is a wide range of risk tolerances across the population of savers and investors. The argument for more stocks may make sense for only a subset of these populations.

Agreed. Just because an approach is better when historically backtested, that does not mean is can be successfully applied by a broad segment of the population in the future. There is a wide range of risk tolerances across the population of savers and investors. The argument for more stocks may make sense for only a subset of these populations.

+1. Thanks Peter.

So many posters tend to see things only through their own window, and they make broad recommendations based on that view. It doesn't work in all cases.

Paul

When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

I strongly recommend what several others have said --- read William Bernstein on this issue (Deep Risk, Investor's Manifesto, Four Pillars, etc.). His analysis and discussion have had a big effect on my own desire to take risk in retirement.

Before reading Bill I would have said I would be 75-25 in retirement.

After reading his work I am planning on being 50-50.

The goal is NOT to die the richest person on the block, the goal is to not die poor.

"It is remarkable how much long term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent." -- Charlie Munger